Building a Dollars-and-Cents Case for Your Proposed Imaging Project
This article is reprinted/republished by the express written permission of IOMA (The Institute of Management & Administration). ©2008; for more information about IOMA publications visit www.ioma.com
The hottest technology in AP over the next few years will be imaging and workflow automation tools. The hardest job AP managers are likely to face is not implementing this new system—but selling the idea to their bosses.
Heaven forbid management should be expected to invest money in AP infrastructure! After all, where’s the "return," asks the top brass?
The frustrating thing is that AP knows the project will save money and pay for itself many times over, but just how do you put this down in black and white? That is, how can you come up with a document that spells out a new project’s benefits in dollars and cents—which is sometimes the only thing upper management understands?
Sharpen Your Pencil
Let’s take a hypothetical company and project and go through the calculations involved in building a business plan. Although we’re doing one for an imaging project, this same framework can be used for any type of project. What’s important to learn is the thought process behind developing your case—and how to develop numbers that make sense.
Our hypothetical company is the Acme Company. To do the calculations the AP manager of Acme needs to know how many invoices are processed and what the total spend is for the year. Acme processes 10,000 invoices per month and makes $500 million in vendor payments each year.
The AP manager wants to implement one of the hot technologies in AP today—imaging. That is, turning paper invoices into digital images, routing them via e-mail for approvals, automatically extracting data for input to the AP system, and storing them in a Web-based repository for instant retrieval when needed.
As we mentioned, the costs of a project such as this are easy to generate—vendors will be happy to give you all of this. Plus, your IT people can help fine-tune these numbers. Your crucial input here is in terms of the hard-dollar benefits this system will generate. Plus, there will be several qualitative (intangible) benefits that cannot be easily calculated—but can be very real.
Quantifying the Benefits
The first step is to think of what areas of your AP’s operations will benefit from an imaging system. There are five areas that will see quantifiable benefits of an imaging system: 1. labor; 2. payment timing; 3. payment accuracy; 4. document storage; and 5. operating costs.
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1. Labor costs
The largest cost component of processing a vendor payment is labor—all of the tasks involved in receiving the invoice, checking it for accuracy, doing the three-way match, resolving discrepancies, routing it for approvals, inputting it for payment, and filing it and the related backup documents.
If you do not know your internal costs for processing a vendor payment, you can use industry benchmark figures.
In our related research, IOMA’s AP Department Benchmarks and Analysis 2005, we found that it costs companies with a low level of automation an average of $11.60 to process a vendor payment. Companies with a high level of automation report this cost to be $6.81 on average—a savings of $4.79 per invoice.
Acme uses these figures to calculate its labor savings. They assume a conservative $2 per invoice savings. Therefore, since they process 10,000 invoices per month, this triggers an annual savings of $240,000.
Where will these savings materialize? They will come from three areas: 1. staff headcount; 2. lower overtime costs; and 3. less need for temps.
AP departments report that dramatic increases in efficiency due to imaging have resulted in either the ability to reduce headcount or eliminate the need to hire additional employees when invoice volume increased. By the same token, employee overtime was reduced as a result of the invoice processing efficiencies and faster cycle times. Also, some AP departments routinely hired temporary staff to help during busy seasons. Typically, they are used for such tasks as filing and research. Because imaging eliminates paper and allows for easy retrieval, the need for temps is diminished.
In Acme’s case, the AP department determines that the entire savings comes from the reduced use of overtime and temps.
2. Payment timing
Vendors may offer a discount if invoices are paid early or by a certain date. On the other hand, vendors will slap a late-payment charge on companies that don’t pay on time. Because an imaging system reduces the AP processing cycle time and allows for more control of the timing of the payment process, more early-payment discounts can be captured and more late-payment penalties can be avoided.
Early-payment discounts: The typical vendor discount is 1% to 2% of the invoice amount if the payment is made within 10 days. A paper-based, manual invoice payment process is so time-consuming that many discounts are lost.
According to a survey by the Credit Research Foundation (CRF) of its members, 54% of vendors offer an early payment discount, but companies are only capturing 63% of the discounts they are offered [CRF Administering Cash Discounts #2]. Using an imaging system with related workflow capabilities that allows for faster processing and approvals can result in the ability to capture more discounts.
For Acme, with its $500 million of vendor payments each year, it determines that 50% of the payments are eligible for a 1% discount. This translates into $2.5 million in available discounts (half of $500 million times 1%). Acme finds out that it is only capturing 60% of the discounts ($1.5 million). Result: Acme can save an extra $1 million if it captures all of them. To be conservative, it assumes that it can capture half of these lost discounts, or $500,000. Still a huge savings!
Late payment penalties: A common by-product of a manual and inefficient invoice payment process is the overdue invoice. Overdue invoices come with a price: the late payment penalty. Just as it can help capture dis-counts, an imaging system that allows invoices to move rapidly through the transaction process can be used to create a payment schedule to eliminate late payment penalties.
We must point out that most large companies don’t have a problem with late payment penalties—regardless of whether they have an imaging system. That’s because they simply do not pay the late charges on most invoices. However, late charges on certain types of invoices must be paid, such as telephone and electric bills.
Acme determines that its late-payment charges are immaterial, so they are not taken into account in the cost savings calculation.
Too-early payments: Companies that do not have control over payment timing will certainly pay some invoices before they are due. This is not a good idea from a cash-flow standpoint. Invoices should be paid on the last day possible to improve and maximize cash flow. An imaging system coupled with a payment scheduling mechanism can ensure that this happens.
Acme, which makes $500 million of vendor payments each year, discovers that 10% of this amount ($50 million) is paid too soon. If Acme can stretch out these payments an extra 10 days, it could save almost $140,000, assuming its cost of capital is 10%.
3. Payment accuracy
With a paper-based AP system, accuracy can suffer—and duplicate payments, input mistakes, and payment errors can cost a bundle. An imaging system that also maps the data from the invoice for automatic upload into the financial systems can eliminate input errors. Automated document storage of invoices and backup documentation can help eliminate duplicate payments and ensure that payments are accurate.
Duplicate payments: When paper invoices are lost or get stuck on someone’s desk, the vendor will send a duplicate. The duplicate is paid, but then the original is found. Unless the AP system has good controls, both invoices could be paid.
According to IOMA’s benchmarking study, 17% of companies surveyed report a duplicate payment rate from 0.1% to 0.5% (percentage of invoices paid twice).
Acme uses a 0.3% duplicate payment rate which, when applied to its $500 million of vendor payments each year, translates into $1.5 million of double payments annually. But Acme does not use this figure in its cost-savings calculation. Reason: The CFO would say to simply pay an audit recovery firm to go out and retrieve those duplicate payments. For that, they typically receive one-third of the recovered amounts. Therefore, the true savings would be $500,000 (because you won’t have to hire the audit recovery firm if the imaging system prevents duplicate payments).
Payment errors: If purchase orders and shipment or receiving records cannot be accessed easily, payment errors can occur. For example, if it is difficult to track and match shipment and delivery documents, a company will end up writing off some inventory due to losses and damages.
An imaging solution that includes indexing, storage, and easy retrieval of all documents associated with the transaction helps to eliminate payment errors and inventory write-offs.
According to IOMA’s benchmarking study, the error rate on vendor payments averages 1.4%.
Acme uses this percentage figure and assumes that half of these errors result in excess payments of 10%. Just focusing on these errors, they represent $350,000 of overpayments (1.4% of the $500 million annual spend times 50% times 10%). They also assume that the imaging system will reduce this overpayment amount by 25%, so the savings will be $87,500 (25% of $350,000).
4. Document storage
The costs of storing paper documents are high, and the risk of losing the documents is significant. According to a Gartner Group study, Electronic Document Management, it costs $18.00 to file a document. The tab for retrieving a misfiled document is about $108.00. Of course, some documents vanish. In fact, 25% of documents in a business enterprise that are misfiled or misplaced are never found. Imaging greatly reduces these statistics.
Prior to implementing imaging, companies stored multiple paper copies of invoices and related documentation in file cabinets or boxes either on-site or at an off-site storage facility.
If document storage is on-site, the occupancy cost of the storage area is often charged to the AP department as overhead. Since an imaging system reduces or eliminates the need for on-site storage, the AP overhead charge would be reduced accordingly. Also, since the paper invoices keep piling up each year, more file cabinets are needed. Digital archiving eliminates the need to buy more filing cabinets each year.
If document storage is off-site, the rental costs can be high. Plus, there can be transportation or shipping costs in getting documents to and from the off-site location. And, of course, retrieval of off-site documents takes time. Companies that use electronic storage of digital images are able to speed up retrieval of the documents and reduce or eliminate the costs related to the off-site facility.
Acme, to keep things simple, figures the cost savings to be the intercompany occupancy charge related to the storage area where the AP files are kept. This charge is $500 per month, so the annual savings are $6,000.
5. Operating costs
Various tasks related to the physical handling of paper documents can rack up costs. For example, the average document is copied between nine and 11 times at a cost of about $16, according to the Gartner Group study. Plus, document mismanagement claims 40% to 60% of office workers’ time; 20% to 45% of labor costs; and 12% to 15% of corporate revenue.
With paper invoices, they need to be shipped, faxed, copied, routed, and shuffled from one location to another. Often, the creation of a paper trail for audit purposes triggers a mountain of physical documents.
The use of imaging can reduce the costs of these various operations. In particular, shipping and postage charges, telephone, fax, printing, and copying costs can be cut or eliminated. Imaging eliminates the need for shuffling paper documents between, for example, the receiving department and the location where the AP department is located.
Acme has no clue as to the amount it spends on these tasks. Therefore, it takes Gartner’s figure of $16 of copying charges per document, and simply uses a figure of $1 per invoice it processes. At 10,000 invoices per month, this means a $120,000 annual savings. Based on the benchmark costs cited above, how could anyone argue with Acme’s assumption?
Intangible Benefits
To further make your case, you need to point out the benefits that are difficult to quantify but are considerable.
With an imaging system, the following intangible benefits can be identified:
Faster dispute resolution: When a vendor calls with a problem about a payment, it can take a lot of time to assemble all of the documents related to the disputed amount. Because of the instant access to documents an imaging system allows, you can corral all of the paperwork in seconds. Multiply the time saved by the number of calls per year, and the total time savings can be huge.
Reduced exposure to disaster: With an imaging setup, electronic storage and back-up systems reduce exposure to potential disasters. That is, paper files are much more susceptible to disaster than digital records, especially if the files are also kept off-site.
Easier audits: Quicker access to archived records make audits go smoother—you don’t have to waste time searching through file cabinets for paper documents that the auditors request. Plus, if they are misfiled, you’ll waste even more time.
Better regulatory compliance: At the heart of the Sarbanes-Oxley Act (SOX) is the need to strengthen internal controls, accountability, and transparency of financial transactions. Certainly, an imaging system that tracks, verifies, and stores all source documents related to vendor payments can be an invaluable way to help comply with the tough new regulatory environment.
Case Closed
The accompanying figure outlines the amounts Acme calculated as the annual dollar value of benefits of the AP imaging project. It simply adds in the cost figures to get the net annual savings per year. Of course, the intangible benefits should be discussed as well.
Don’t be surprised by these figures—there are many companies that have experienced this magnitude of savings from an imaging system. A payback period (time it takes to recoup the investment) of less than one year is not unusual.
In any event, what’s important in this exercise is to learn how to document a project’s savings in a way that the top brass can understand—and can use to compare with all of the other capital requests it receives from the entire company. If you can do that, your chances of getting your project funded will increase dramatically.
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